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Why Standard Motor Products, Inc.’s (NYSE:SMP) Return On Capital Employed Is Impressive

Simply Wall St

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Today we are going to look at Standard Motor Products, Inc. (NYSE:SMP) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Standard Motor Products:

0.19 = US$110m ÷ (US$913m - US$346m) (Based on the trailing twelve months to March 2019.)

Therefore, Standard Motor Products has an ROCE of 19%.

Check out our latest analysis for Standard Motor Products

Is Standard Motor Products's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Standard Motor Products's ROCE is meaningfully higher than the 16% average in the Auto Components industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Standard Motor Products compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

You can see in the image below how Standard Motor Products's ROCE compares to its industry. Click to see more on past growth.

NYSE:SMP Past Revenue and Net Income, July 8th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Standard Motor Products's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Standard Motor Products has total assets of US$913m and current liabilities of US$346m. Therefore its current liabilities are equivalent to approximately 38% of its total assets. Standard Motor Products has a middling amount of current liabilities, increasing its ROCE somewhat.

What We Can Learn From Standard Motor Products's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Standard Motor Products shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.